If you are a small business owner, chances are good that you will need to lease commercial space at some point. Whether you need to find somewhere to house your office, a retail storefront or warehouse space for your products, understanding how commercial leases work and knowing about potential pitfalls ahead of time can help you avoid costly and time-consuming problems in the future.
Understanding the Types of Commercial Leases
In a commercial lease, you pay a certain amount of rent for each square foot of space. There are two main types of commercial leases: gross leases and net leases.
- Gross Leases. A gross lease essentially means that the rent you pay per square foot includes all expenses, including real estate taxes, utilities, and maintenance.
- Net Leases. In a net lease, your rent amount per square foot is lower, but you’ll pay additionally for three categories of expenses: taxes, insurance, and common area maintenance (CAM) expenses. There are different types of net leases, including single net leases, double net leases and triple net leases. In a single net lease, the tenant is response for one of these categories of expenses, for example, taxes. In a triple net lease, the tenant is responsible for all three categories of expenses: taxes, insurance and CAM fees.
Spotting Potential Pitfalls
No two commercial leases are the same and reviewing a commercial lease can be a challenging task for a prospective commercial tenant. Additionally, there are fewer laws protecting consumers when it comes to commercial leases, as business owners are expected to be more savvy than individuals leasing residential properties. By understanding key provisions and negotiating terms most favorable to the tenant, a commercial tenant is able to mitigate his or her risk and liability in the event of an unforeseen circumstance.
Here are a few key commercial lease provisions that you should carefully review and consider before executing a commercial lease.
If you are entering into a gross lease, find out which expenses are included in the rent, and whether there are caps on the landlord’s responsibility and liablity. Your landlord could choose to charge you for excess utilities or additional janitorial services beyond a basic level described in the lease.
Similarly, don’t make an assumption that a single net lease is the same as a triple net lease; it’s not. If you don’t understand the difference, you could find yourself paying for expenses you assumed were covered in your rent payment.
2. CAM Fees.
A standard commercial lease usually places a large portion of common area maintenance (e.g., parking lots, common restrooms, garbage collection, sprinklers, and utilities for common areas like hallways and entryways) on the tenant. Prospective tenants should consider the age of the building and try to limit responsibilities for common area maintenance.
In many cases, tenants can negotiate the fees they pay for common area maintenance before signing a commercial lease. Many prospective tenants aren’t aware that this is an option and simply agree to the fees presented by their prospective landlords.
3. Option to Renew.
Many commercial leases have a renewal provision. The renewal provision grants the tenant an option, or several consecutive options, to renew the lease for a set term or several set terms after the expiration of the initial term of the lease. Without a renewal provision, a business owner may be forced to relocate his or her business, thus creating a major disruption and unexpected expenses. Lease renewals should be reviewed for the specific term, but also the costs of renewals and the mechanism of determining what a fair and reasonable rent is under a lease renewal.
4. Damage and Destruction.
Commercial leases often contain a provision stating if less than fifty percent (50%) of the tenant’s rented space is deemed untenable by fire, water damage, etc. then the tenant’s rent will be abated until the landlord repairs the premises. Before signing the lease, the tenant should consider what percentage of the leased space, if any, their business can afford to lose without substantially affecting their business operations.
5. Maintenance and Repairs.
You should also understand who will be responsible for paying for repairs or maintenance costs when they come up. Unlike residential leases, commercial leases can – and sometimes do – require tenants to pay for repairs to things like plumbing, heat and air conditioning systems, and other types of mechanical issues. Assuming your commercial landlord will cover these expenses could be a costly mistake when something breaks.
Often commercial tenants have un-used space that can be subleased to a third-party to generate additional income. Many commercial leases contain provisions restricting a tenant’s ability to assign or sublease all or a portion of the leased property. Reviewing a commercial lease’s subleasing provision during the due diligence period is important because this provision often can be negotiated with the commercial landlord.
Most commercial leases include a provision that places a lien on all fixtures and equipment that the tenant has in the rental space. This lien helps secure the tenant’s payment of the monthly rental installments to the landlord. It is important for the tenant to review any lien provision in a commercial lease and obtain any consent required by the lease before he/she remodels, replaces or sells any of the fixtures or equipment installed in the space to avoid breaching the lease.
8. Personal Guaranty.
It is common for commercial leases to include a personal guaranty which requires the individual owner(s) of a corporate tenant to be personally responsible for all obligations under the lease, including payment of any rental installments or other expenses. Because these amounts can be significant, it is important for any tenant to be aware of this obligation. It is also important for tenants to be aware that this obligation is negotiable and that other security can be provided to release this obligation.
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